On Friday, Balearic Islands and Asturias joined the autonomous regional governments of Andalusia, Canary Islands, Castile-la Mancha, Catalonia, Murcia, and Valencia (see Fig. 1) in asking help from Madrid's newly created Regional Liquidity Fund (FLA), an €18 billion credit facility to provide affordable financing to the fiscally ailing regional governments. With an increasing number of the 17 regional governments seeking help from Madrid, the liquidity fund is being pushed to its limit. The fiscal woes of the regional governments came to the forefront when Valencia sought a bailout in July from the Spanish state for €4.5 billion, followed by Catalonia in August for €5 billion, to meet their debt obligations. The Mediterranean regions of Valencia and Murcia subsequently requested similar aid, although on a smaller scale. Early in September, Andalusia declared that it would have to seek help from Madrid to tide over its fiscal woes; various estimates put the amount at about €5 billion. Only Madrid, La Rioja and Galicia out of all the regions have ruled out tapping the FLA.
Data from Spain's Central Bank, Bank of Spain, puts the outstanding debt of all the 17 regions to €150.6 billion as of Q2, 2012, with the total debt of Catalonia, Valencia, Madrid, and Andalusia constituting 65% of the total (see Fig.2). The total outstanding debt of all the autonomous regions in terms of debt-to-GDP ratio is about 14% of the Spain's total economic output, while Catalonia and Valencia stand at 22% and 20.8% of their outputs, respectively (see Fig. 3).
If you look at Fig. 4, the total outstanding regional debt as of Q2, 2012 registered a 107.3% increase from €72.6 billion at the end of 2007, when the global recession hit Spain.
With Spain mired in a banking crisis, a second recession in three years, an unemployment rate of more than 25% and an increasingly unsustainable national debt burden, the autonomous regions' accumulation of huge debts and deficits have for all purposes put Madrid now on a path of full-blown bailout from the eurozone's permanent bailout fund, the European Stability Mechanism (ESM). The question now is when? In 2011, the collective budget deficit of all the regional governments was reported at 2.9% of Spain's GDP, and that is about one-third of Spain's overall national deficit of 8.5%, and way above the 1.3% target set by Madrid.
How did the autonomous regions get to this point? If you look at Fig. 1, it's no coincidence that the Mediterranean regions such as Catalonia, Valencia, Murcia, and Castile-La Mancha are in dire straits. They were the beneficiaries of the real-estate boom which took off when Spain joined the euro, and went bust abruptly in 2008. During the decade-long boom years, the coffers of the regional governments raked in unprecedented revenues from enhanced property sales and building permits, VAT collection from consumer spending, and income tax collection from immigrants who came to work on construction sites. But, the problem was that the regions instead of establishing strong counter-cyclical fiscal policies, based on sound financial management principles, threw caution to the wind and went on a spending binge. They hired public employees who cannot be fired, provided increasingly expensive healthcare, especially for the growing elderly population, built massive white elephant infrastructure projects, airports (Valencia has built an airport at which a single plane is yet to land), gleaming government buildings, public swimming pools, and so on and so forth.
And so when the great recession hit Spain in 2008, tax revenues dried up while the spending commitments remained. The subsequent widening of their fiscal balances forced the regions to look to international markets to fund the shortfalls. General administration, the institution that caters to providing public services to the regions including social services, health, education, and infrastructure, racked up a monumental debt of about €83 billion in more than 4.5 years since the end of 2007 (see Fig. 4).
But, the eurozone crisis that began in the periphery following the great recession of 2008 finally hit Spain, the eurozone core, early this year. This served to enhance the risk premium on Spain's sovereign debt, and so, along with all the economic woes ailing Spain, all the Spanish autonomous regions have been locked out of the international markets from financing their widening deficits.
As you can see in Fig. 5, the year-over-year growth of regional debt since 2007 peaked at the end of 2010 at 32.8%, and then declined to a year-over-year growth of 17% at the end of last year, reflecting the strain in the international debt markets in funding the fiscal imbalances of the regions. With a devolved quasi-federal structure in Spain, the autonomous regions are responsible for 1/3 of the overall national public spending, which are financed primarily by their tax revenues and the rest, about less than 20% of their spending, is funded by the Spanish state tax-revenues. With the regional tax revenues drying up after the real estate bust, a bloated spending overhang is remaining from the binge days. And with Spain in the throes of a second severe recession in three years, the regions have increasingly become cash-strapped and looking to the Spanish State to bail them out.
As you can see in Fig. 6, among the regions on the Mediterranean where the real estate boom was dominant, Catalonia, Spain's largest regional economy, about the size of Portugal's, is the hardest-hit from the bust - with its debt rising precipitously to €43.9 billion in Q2, 2012 from €15.8 billion at the end of 2007, about slightly less than a twofold increase in more than four years. Similarly and to a lesser extent, Valencia and Andalusia registered a meteoric rise of €9.5 billion and €8.3 billion, respectively, in the same period.
Fig. 7 captures the contrast of the debt-burden of the regional governments before the great recession of 2008 and after: The total regional debt grew at an annual rate of 7.1% in the boom days from 1995 to 2007, and then grew at an annual rate of 21.3%, a threefold increase.
Since 1989, when the "Washington Consensus" was evolved between the U.S. Treasury department, the IMF, the World Bank and the G-7 countries, counter-cyclical fiscal policies were prescribed as a core component of macroeconomic stabilization programs. They were applied numerous times in the nineties during various episodes of sovereign debt crises in Latin America, arising from boom-bust scenarios akin to the one playing out in Spain right now. The irony is that Spain, a player in the G-7 fold that prescribed the counter-cyclical fiscal policies during those episodes, failed to apply those principles to its renegade regions. Over and over again, it seems to me that lessons learned from prior crises are quickly forgotten, and what used to be a phenomenon of the emerging and under-developed world, is recently being repeated very often in the northern side of the North-South economic divide. Is the U.S. government listening?
The fiscal indiscipline that has brought Spain to the doorstep of a full-blown bailout is slowly spilling in to the political realm, with various autonomous regions clamoring for complete fiscal devolution from the Spanish State, and some- like Catalonia- even clamoring for self-determination. The rampant unemployment currently running more than 25% among the unemployed youth can turn out to be a lethal mix with the political discontentment that is brewing in some of the regions. We have to wait and see.
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